Monday, November 3, 2008

China is starting to worry about the effect of the global slowdown on their economy.

China's State Council announced a plan to increase export tax rebates in order to protect domestic industries. Rebates would go to labor-intensive products like garments and textile to high-value products like mechanical and electrical products.

These measures may be against China's obligations under international law.

Worth noting, the U.S. Bush administration has become so dependent on China's purchasing of Treasury bonds needed to finance a bailout of the American financial system that they have stopped criticizing China's trade and currency policies.

China may be violating international law and there is nothing the U.S. can do.

Or is there? Let's go to EIL's big three questions:

WHAT ARE THE ISSUES?

1.) Does China's export rebates violate international law?

2.) Can China's trading partners do anything to stop China's violation of their international legal obligations?

WHAT IS THE CONTROLLING INTERNATIONAL LAW?

Issue 1's Legal Analysis

When you see a trade issue in an international setting, you should immediately look to the World Trade Organization (WTO).

The SCM defines a subsidy in Article 1 to be an act that either is a direct transfer of funds or failing to collect funds - by a government, public body, or a private group entrusted by the government - to confer a benefit (on domestic producers).

Article 3.1 states that subsidies would be prohibited if they fall into two types:

(a) subsidies contingent, in law or in fact, whether solely or as one of several other conditions, upon export performance, including those illustrated in Annex I;

(b) subsidies contingent, whether solely or as one of several other conditions, upon the use of domestic over imported goods.

In this list is the key to determining if China's export rebates are illegal under the WTO.

Part (g) of the list reads:

(g) The exemption or remission, in respect of the production and distribution of exported products, of indirect taxes in excess of those levied in respect of the production and distribution of like products when sold for domestic consumption.

What does that mean? It means a government can give back to exporters the taxes they paid for materials needed to produce their goods - but only for products being exported.

Part (g) of the ILLES also limits the amount of money that can be given back to producers. The money rebated can be no more than the taxes levied on the same product being sold in that nation.

For example, a company in China manufactures televisions. Some get sold in China; some get sold abroad.

For the televisions that get sold in China, the Chinese government collects taxes. The components and raw materials used to make the television are taxed when this company buys them. Taxes are also paid when the televisions are sold. China uses a value-added tax system (VAT). Eventually, the manufacturing company gets a tax break due to the taxes on the final sale of the TV to a Chinese consumer.

For the television sold abroad, the Chinese government would not get taxes from the final sale. Those taxes would be collected by the government in whatever nation that television arrives. So the manufacturer loses money as they no longer get the tax break they would normally get for domestic sales.

Part (g) of the ILLES allows China to rebate to the television producer a similar amount as if the TV had been sold in China - but no more than that.

This is the crux of whether China's export rebates are legal.

Is China giving a rebate higher in excess of the indirect taxes levied on similar products consumed domestically?

It is in China's interest to keep their exports high. This brings in tremendous revenue to the country. These rebates allow Chinese producers to keep the costs of their products extremely competitive in the world market.

It is in the U.S.'s interest (to a degree) to keep the prices of goods low too. Consumer spending in the U.S. is dropping to record lows. Considering that consumer spending accounts for 2/3 of the U.S. Gross Domestic Product (GDP), pursuing a dispute resolution that leads to more costly goods from China may not be a smart short-term move.

What will probably happen is that China's higher export rebates will be scrutinized by their trading partners.

At some point, a trading partner will file a complaint with the WTO DSB.

Resolving the dispute will be a lengthy process that allows China to keep the costs of their manufactured goods low long enough to help their manufacturers.

Consumers worldwide will benefit from the cheap goods to which we've become addicted. When the economy rebounds, the DSB can rule on the matter of the rebates.

China can then withdraw the rebates without harming their own economy.